Lawmakers consider changing tax breaks on retirement savings

The painful trade-offs of tax reform came into sharper focus Tuesday as lawmakers for the first time began considering specific tax breaks to reduce or otherwise change, starting with laws that allow millions of Americans to avoid taxes while saving for retirement.

Tax incentives for employer pensions, 401(k) plans, individual retirement accounts and other savings programs rank among the largest breaks in the tax code, costing Washington more than $200 billion a year in lost revenue.

All told, the U.S. Treasury loses about $1.1 trillion annually to more than 200 credits, deductions and other tax breaks. Politicians in both parties — including President Obama and Mitt Romney, the Republican who is likely to challenge his reelection bid — have called for recapturing some of that cash and using it to finance lower tax rates or to reduce federal budget deficits.

Until recently, both sides have been reluctant to hint at which of the many popular perks might get the ax. That is starting to change, however, as lawmakers and policy analysts begin preparing for the prospect of overhauling the tax code as soon as next year.

On Tuesday, House Ways and Means Committee Chairman Dave Camp (R-Mich.) scheduled a hearing on “tax-favored retirement accounts” that he said was intended to begin “framing the debate” in preparation for tax reform. Aides said Camp also is planning a first-ever examination of about $30 billion worth of expired tax breaks for individuals and corporations that Congress routinely extends, an idea that is also gaining traction in the Senate.

Over the weekend, Romney dropped hints about tax reform at a private fundraiser in Florida, telling donors that he would save money by eliminating or limiting the mortgage-interest deduction for second homes for taxpayers with high incomes. He also suggested limits on deductions that millions of Americans claim for state income and property taxes.

Romney’s remarks, overheard by reporters for the Wall Street Journal and NBC News, quickly drew fire from the Obama campaign, which accused the former Massachusetts governor of harboring a secret plan to undermine the middle class.

Romney aides later said the candidate was merely throwing out ideas, not outlining a fully formed plan for tax savings.

During Tuesday’s hearing, Camp trod carefully, urging lawmakers to consider whether the complex web of retirement savings provisions could be streamlined to encourage more people to sock away money. He did not suggest trimming benefits, noting that an “overwhelming majority” of full-time workers — 66 percent — rely on the provisions.

“Today’s hearing isn’t about drawing conclusions,” Camp said, but about “making sure that as Congress approaches comprehensive tax reform that we do so well-armed with information.”

Democrats nonetheless pounced, arguing that Camp’s goal of lowering the top tax rate to 25 percent from the current 35 percent without increasing budget deficits would require lawmakers to eliminate virtually every break in the tax code. If preferences for retirement savings were preserved, they said, then something else would have to go.

“Today’s testimony issues a warning for those who propose to eliminate all tax expenditures or equate them with special interest ‘loopholes,’ ” said Rep. Sander M. Levin (Mich.), the senior Democrat on the panel. Provisions for retirement savings are “not a loophole,” Levin said, adding later: “This is a vivid example of why it’s reckless to say you’re going to get to a certain tax rate without saying how you’re going to get there.”

Camp fired back at his Democratic critics, saying, “I don’t think anyone is proposing to eliminate” incentives for retirement savings. Later, he told reporters that the Republican tax plan would not require wiping out every break on the books.

“We do not have to eliminate all expenditures to get to 25 percent,” he said.

Still, a growing body of research suggests that many, if not most, tax breaks would have to undergo surgery for Republicans to meet their target for lower tax rates.

In a forthcoming report, researchers at the Brookings Institution’s Hamilton Project found that lawmakers would have to get rid of all but about $200 billion a year in tax breaks — roughly four-fifths of their value — to reduce the top rate to 25 percent.

And few of the largest preferences would be easy to eliminate, according to researchers at Hamilton and elsewhere, because they benefit huge numbers of taxpayers at all income levels. The single largest break, for example — the tax-free treatment of employer-provided health care — increases after-tax income by 2.5 percent to 3 percent for families earning $19,000 to $243,000 a year.

“One thing that’s pretty clear: Individual income tax expenditures hit a pretty broad swath of people in the middle of the income distribution,” said Adam Looney, policy director for the Hamilton Project.

Tax preferences for retirement savings tend to provide bigger benefits to wealthier taxpayers, who not only are able to save more but also receive a more valuable tax break because they pay higher rates. Still, about 70 percent of workers earning $30,000 to $50,000 a year also benefit from the provisions, Judy Miller, director of retirement policy at the American Society of Pension Professionals and Actuaries, said in testimony Tuesday.

At a time when many Americans are anxious about retirement, Randolf Hardock, testifying for the American Benefits Council, said that “reducing retirement incentives to pay for other initiatives would be counterproductive.”

Lori Montgomery covers U.S. economic policy and the federal budget, focusing on efforts to tame the national debt.
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